The private equity barbarians are at Telus's gate. Darren Entwistle hasn't raised the portcullis. But in time, he might. This is a CEO who doesn't shy away from radical transformations if he thinks they'll improve the growth potential. Remember, he was willing to recast Telus through an income trust conversion.
Mr. Entwistle, the boss of Canada's second-biggest phone company, isn't sharing his thoughts on the public-versus-private debate. We know private equity players have run Telus's numbers through their spreadsheets a million times; that's their job. We know Gerry Schwartz's private equity buccaneers at Onex offered to buy Telus last August at a share price rumoured to be in the mid-$60s.
Sources say Mr. Entwistle, 44, has been fielding phone calls from the private equity mob since then (Onex, distracted by endless aerospace investments, is not thought to be among the callers). Some of the friendly approaches came shortly after the trust clampdown announced on Halloween by Finance Minister Jim Flaherty.
These sources say none of this should come as a surprise. With so much money around -- The Wall Street Journal says private equity funds are sitting on $750-billion (U.S.) of unspent loot -- Manitoba Telecom could get obliterated from the public markets, too.
But Telus is the more tempting prize. With a market value of about $19-billion (Canadian), it is bigger, more diversified and has enviable wireless growth. In fact, the company, measured by total shareholder return, has substantially outperformed both the Morgan Stanley Global Telco index and the Toronto market since 2000, the year it plunged into the wireless pool through the $6.6-billion Clearnet acquisition.
When Onex approached Telus, the shares were trading at about $50. A month later, after phone boy unveiled the trust conversion, they hit almost $65, then plunged to $55 when Mr. Flaherty doused the trust bonfire. If private equity investors are willing to offer $65 a share -- perhaps more given Telus's wireless growth -- why wouldn't Mr. Entwistle hit the private equity button? Greed alone should motivate him. He makes about $10-million a year in salary, bonus and options. He could easily make 10 or 20 times as much as an investor in, and CEO of, a private Telus that is restored to the market through an initial public offering in five years or so.
In spite of the motor yacht and the penchant for fine living -- Telus has a private jet and Mr. Entwistle just bought an expensive house in Toronto -- he has always been open and apparently sincere about his desire to put Telus first. He wants the company to grow nationally and ensure the domestic phone-to-TV network is competitive. He likes to spend, in other words. If a private equity deal were to crimp his ability to invest, he would probably resist the idea.
Last year, Telus's capital expenditure budget was $1.6-billion. This year, against shareholders' wishes, he's ramping it up to $1.75-billion. The company is spending about $200-million a year to install high-capacity fibre cables into neighbourhoods. Telus is one of the few phone companies where capital expenditures are rising in 2007. Mr. Entwistle wants to keep those investments intact, all the better to boost speeds for high-definition TV, Internet downloading and the like. Vidéotron, the cable company owned by Quebecor, is experimenting with cable speeds of 100 megabits a second, five times faster than its existing "Extreme Plus" Internet service. The point being, higher speeds require higher capital expenditures.
The fear for any CEO considering a privatization is that the interest on the debt will wipe out the capital expenditure budget, constraining the company's ability to grow. Let's do some rough calculations. Let's say a privatized Telus is loaded with $20-billion of debt. At 7-per-cent interest, the annual debt payments would be $1.4-billion. At 8 per cent, they would be $1.6-billion, or exactly the value of the 2006 expenditures budget. Of course, a privatized Telus could carry billions less in debt, depending on how conservative the new investors want to be, but you get the idea.
Under this scenario, it seems unlikely Mr. Entwistle would pursue the private equity option. But the argument isn't so one-sided. That's because privatization can save money in other areas. For example, the dividend payments (37.5 cents a quarter) to the existing shareholders would be eliminated. A privatized Telus could bring its tax liability down considerably, because interest on debt is deductible. Between the two, a privatized Telus could save more than $1-billion a year. All of a sudden, privatization looks more attractive, but only if the private equity owners were to apply the dividend and tax savings to the expenditures budget. They could very well keep it for themselves to buy yachts and islands.
What will Mr. Entwistle do? No one knows. But he can't ignore a) that great gobs of private equity are sloshing around the market and it all has to be spent, meaning prices will go up; b) that private equity is interested in Telus; c) that the current share price is still well below the price range Onex is thought to have pitched; and d) that at a certain price, he has the fiduciary obligation to take any serious offer to the board, whether or not the offer compromises his ambitious strategy.
Waiting won't hurt. The private equity players aren't going away. As the number of privatization targets diminishes, and as the value of the private equity funds rises, any price pitched now might be less than the one they're willing to pitch in six months or a year. Moreover, Telus investors seem more gruntled that disgruntled because Telus shares have climbed a few bucks from their post-Flaherty lows. They are putting no pressure on Mr. Entwistle to pursue the privatization route, at least not now.
Mr. Entwistle could wait and see where the shares settle later this year. If their value doesn't improve, he may decide to beat the private equity crowd at their own game. Telus, with its $1.1-billion of free cash flow a year, could certainly carry more debt without blowing its brains out (the current debt payments are about $440-million). The company's debt-to-EBITDA ratio is 1.6 to 1. The ratio at Bell Canada owner BCE is 2 to 1. At least one private equity boss thinks Telus could get away with a ratio as high as 3 to 1, though the ratings agencies would have nasty things to say about that.
Mr. Entwistle has options. The man thinks Telus is worth more than $57 a share. If he can't do it, private equity investors would be happy to help.
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